Slicing Apple's profits: It's not all sweet

Only 54 countries have a GDP greater than Apple’s cash mountain but it's not all fun and games at Cupertino. Gaming the system on tax won't work forever.

Apple Inc, the US-based tech giant, has received plenty of plaudits for producing a record US$18 billion in profit from one quarter’s global sales of US$75 billion. A look at the company’s financial statements shows it has cash and marketable securities of some US$178 billion.

Only 54 countries have a GDP greater than Apple’s cash mountain. This is a remarkable achievement for a company which 15 years ago was struggling to survive.

But the company’s success also highlights the problems ahead. Maintaining its gross profit margin of nearly 40 per cent will be difficult, as Apple relies on relatively few products. In the fickle market of fads, fashions and intense competition, the shelf-life of products is short. iPad sales are struggling and, to prevent the same fate from awaiting its iPhone, Apple must constantly persuade customers to pay premium prices for its products. Tax and management of its cash mountain are also major problems.

International sales accounted for 65% of Apple’s record-breaking revenue. Fundamental to these profits is the availability of an educated and healthy workforce and good transport and legal systems around the world. All this, let’s remember, is funded by tax revenues, but the company has devised a variety of strategies, all legal, to reduce what it pays out in tax.

The committee reported that Apple paid US$5.3 billion in US corporate taxes between 2009 to 2011 on its global profits of US$65 billion over that period (the US levies taxes on the worldwide profits of companies). Apple’s effective US tax rate was eight per cent compared to the headline rate of 35 per cent, as the US gives credit for taxes already paid abroad.

The senate committee, however, reported that Apple had not paid corporate tax to any national government for the preceding four years. Its 2014 accounts (see the report, pages 63-64) show that on foreign profits of US$33.6 billion it may pay tax of only US$2.15 billion, an effective rate of 6.4 per cent. If we take the UK as an example, despite sales totalling billions of pounds, the company’s effective tax rate has varied from zero to 1% of its UK profits.

Playing the system

Apple exploits international tax systems to shift profits to low/no tax jurisdictions. A key part of its tax strategy is to register intellectual property (such as patents, logos and trademarks), distribution, marketing and assembly rights in subsidiary companies in low/no tax jurisdictions. With a corporate tax rate of 12.5 per cent Ireland is a favourite destination. Foreign sales are routed through subsidiaries registered there and, through special tax deals with the Irish government, pays taxes nowhere.

The irony of all this is that Apple’s profits are causing an increasing build-up of cash and marketable securities that the company isn’t free to use in any way it wants. The current cash mountain of US$178 billion is largely managed through Braeburn Capital, a subsidiary company located in Nevada in the US (a state that doesn’t levy any corporate income tax on profits).

Only US$19.5 billion of this stockpile is in hard cash. The rest is invested in a variety of marketable securities. The return on these is paltry compared to Apple’s profit margins. But how to invest this cash mountain is problematic, as it strives to legally avoid paying taxes wherever possible.

Apple has used it to diversify and buy other companies such as Beats Electronics, but there are inevitably issues about dovetailing the new entities into the company. There is also the option of repatriating cash into the US by paying higher dividends to its shareholders, as some have demanded. But this income would be subject to higher rates of income tax – something Apple’s executives are not keen on.

Another option is using its stockpile to buy back shares (gains made on the sale of shares are taxed at lower rates). But this would mean repatriating some of the cash to the US, which would then be treated as repatriated profits and taxed at 35%. So Apple’s solution is to borrow money to partly finance the buyback of its shares. Despite spending more than US$90 billion to buy back its own shares, the cash mountain remains and continues to grow with soaring iPhone sales.

So, it is not all sweetnesss for Apple as the company faces major challenges on product innovation, customer loyalty, tax and shareholder demands for higher returns.

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